Kevin Jun Lin, Corporate Lawyer

I. Case: A “Breakup” Crisis Worth Tens of Millions

In 2023, an internet startup named “SD Technology” completed its Series A financing, reaching a valuation of RMB 50 million. Its three founders — Jia (CEO, 40% shareholding), Yi (CTO, 30% shareholding), and Bing (COO, 30% shareholding) — completed the equity registration shortly after the company’s establishment.

However, only 18 months after the company’s establishment, the CTO Yi resigned for personal reasons and claimed that the 30% equity under his name (corresponding to a valuation of RMB 15 million) should belong to him personally. Jia and Bing, on the other hand, argued that Yi had not fulfilled the long-term service obligation that a founder should bear, and should not take away all the equity.

Because the articles of association and the shareholders’ agreement did not include an equity vesting clause, the two sides reached a deadlock. Yi filed an action for confirmation of shareholder status, demanding confirmation of his complete shareholder rights; Jia and Bing contended that Yi had violated the principle of good faith and demanded the return of part of the equity.

Eventually, the court held that the equity had been registered under Yi’s name, and there was no valid and legally effective agreement restricting its disposition, so Yi was entitled to the corresponding equity. This judgment plunged the company into a serious governance crisis, forcing a halt to subsequent financing and a sharp drop in valuation.

This case reveals a harsh reality: without the protection of an equity vesting mechanism, when a founder leaves midway, the company may face the predicament of “the person leaves, yet takes the equity with them.” For a startup, this is not only an economic loss but also an existential crisis.

II. What Is the Equity Vesting Clause (Vesting)?

(1) The Core Meaning of Vesting

Equity vesting (Vesting) refers to a mechanism whereby the equity obtained by a founder or core team member does not vest all at once, but gradually “vests” and ultimately becomes fully owned based on the duration of their continuous service to the company or the performance targets achieved.

Simply put, Vesting is an equity incentive mechanism of “installment vesting”: you promise to serve the company for a certain period, and the company promises to gradually and truly “give” you the equity during that period. If you leave early, the unvested equity will be forfeited or repurchased.

This mechanism originated in Silicon Valley, USA, and has now become standard practice for startups worldwide. Its core logic is that equity is a reward for future contributions, not compensation for past input. Only by continuously creating value for the company can one ultimately obtain the complete equity.

(2) Legal Nature of Vesting

From a legal perspective, the Vesting clause is a contractual arrangement among shareholders, typically reflected in:

1. Shareholders’ agreement — an agreement signed among shareholders stipulating vesting conditions, repurchase mechanisms, etc.;
2. Articles of association — incorporating the Vesting clause into the articles enhances its effect against third parties;
3. Equity incentive plan — such as the management rules for an option pool;
4. Equity transfer restriction agreement — restricting the transfer, pledge, and other dispositions of unvested equity.
   

Under the relevant provisions of the Contract Part of the PRC Civil Code, the Vesting clause, as a consensus among shareholders, should be recognized as valid as long as it does not violate mandatory legal provisions. Courts generally respect the parties’ autonomy of will and uphold the enforcement of Vesting clauses.

III. Common Vesting Mechanism Designs

(1) The Classic Time-Based Vesting Model: 4-Year Vesting with a 1-Year Cliff

The internationally prevalent Vesting design is “4-year vesting with a 1-year cliff” (4-Year Vesting with 1-Year Cliff), with the specific operation as follows:

Key Points:

1. Monthly vesting In practice, the vested proportion is usually calculated on a monthly basis (e.g., 1/48 per month) rather than annually. This is more precise and avoids the arbitrage of “working 11 months then leaving.”
2. Cliff The purpose of setting a 1-year cliff is to screen out founders who are genuinely willing to cooperate long-term. If someone leaves within one year, it shows they are not truly committed to the venture and should receive no equity.
3. Accelerated vesting Under specific circumstances (e.g., the company is acquired, or the founder passes away), it may be agreed that all or part of the equity vests on an accelerated basis.

(2) Treatment of Equity upon Departure

When a founder departs, the treatment depends on the reason for departure and the vesting status of the equity:

1. Vested Equity:

• Usually owned by the founder, and the company has no right to force a repurchase (unless there is material fault);
• However, it may be agreed that after the founder’s departure, the company enjoys a right of first refusal to repurchase the vested equity at a reasonable price, preventing the equity from falling into the hands of competitors.

2. Unvested Equity:

• The company has the right to forfeit or repurchase at a nominal price (e.g., RMB 1);
• The repurchased equity may: (1) return to the option pool for incentivizing subsequent talent; or (2) be redistributed pro rata among the remaining shareholders.

(3) Designing Accelerated Vesting Clauses

Accelerated vesting means that upon the occurrence of a specific triggering event, the unvested equity vests in whole or in part ahead of schedule. Common acceleration scenarios include:

1. Single-trigger acceleration When the company undergoes a change of control (e.g., is acquired), the founder’s equity vests fully on an accelerated basis. This clause favors the founder but may hinder M&A transactions.
2. Double-trigger acceleration Only when the company is acquired and the founder is subsequently dismissed without cause or suffers a materially adverse change in role does accelerated vesting trigger. This is a more balanced design and the version preferred by institutional investors.
3. Founder’s death or loss of capacity It is usually agreed that all equity vests on an accelerated basis, owned by the heir or the founder themselves, reflecting humanitarian concern.
4. Company IPO Some companies agree that if the company successfully goes public, all unvested equity vests at once as a reward to the founding team.

IV. Statutory Interpretation: The Contract Law Basis of Vesting

📖 Relevant Provisions of the Contract Part of the PRC Civil Code

Article 509 The parties shall fully perform their obligations in accordance with the agreement. The parties shall, in accordance with the principle of good faith, perform such obligations as notification, assistance, and confidentiality, in light of the nature and purpose of the contract and the course of dealing.

Application of law: As an important component of the shareholders’ agreement, the Vesting clause is legally binding on the signing shareholders. A shareholder’s failure to provide services as agreed or early departure constitutes a breach, who shall bear corresponding liability (e.g., the equity being repurchased).

Article 563 Under any of the following circumstances, a party may rescind the contract:

(1) force majeure renders the purpose of the contract impossible to achieve;

(2) before the expiration of the performance period, one party expressly states or indicates by its conduct that it will not perform its principal obligation;

(3) one party delays performance of its principal obligation and, after being demanded, still fails to perform within a reasonable period;

(4) one party delays performance or commits other breach that renders the purpose of the contract impossible to achieve;

(5) other circumstances provided by law.

Application of law: If a founder commits a material breach (e.g., starting a rival business or violating a non-compete covenant), the company may rescind the Vesting agreement under this article and demand the return of the unvested equity.

Article 577 Where a party fails to perform its contractual obligations or performs them contrary to the agreement, it shall bear liability for breach of contract such as specific performance, remedial measures, or compensation for losses.

Application of law: A founder’s early departure constitutes a breach of contract, and the company is entitled to require the founder to bear liability for breach, including repurchasing the unvested equity at the agreed price.

(1) The Validity Boundaries of Vesting Clauses

Although the Vesting clause is valid in principle, the following legal risks should be noted:

1. Must not violate the principle of free disposition of equity For vested equity, the shareholder enjoys complete ownership, and the company may not unreasonably restrict its transfer (but a right of first refusal may be agreed).
2. The repurchase price must be reasonable If the company is to repurchase unvested equity at a “nominal price” (e.g., RMB 1), the clause should be clearly worded to avoid being set aside as “manifestly unfair.”
3. Must not restrict personal rights A Vesting clause may not restrict a shareholder’s personal freedom or freedom of employment, otherwise it may be void for violating public order and good morals.

(2) Coordination Between the Articles of Association and the Shareholders’ Agreement

Under the provisions of the newly revised Company Law, the articles of association are binding on the company, shareholders, directors, supervisors, and senior management. Therefore, incorporating the Vesting clause into the articles enhances its legal effect against third parties.

Note, however, that amending the articles requires a shareholders’ meeting resolution (usually adopted by more than two-thirds of the voting rights), whereas a shareholders’ agreement only requires the consent of the signing shareholders. Therefore, the best practice is: set out the Vesting mechanism in detail in the shareholders’ agreement, while incorporating the core clauses (such as the equity repurchase right) into the articles in simplified form.

V. Practical Points: How to Design an Effective Vesting Clause? 💡 Practical Guidance

Point 1: Clarify the vesting start time

The vesting start time may be: (1) the date of the company’s establishment; (2) the date the shareholder subscribes for equity; or (3) the date the shareholder begins providing services. It is recommended to expressly agree on this in the shareholders’ agreement to avoid disputes.

Point 2: Distinguish “good-faith departure” from “bad-faith departure”

The reasons for a founder’s departure are complex and should be treated differently:

• Good-faith departure (e.g., for health reasons, family circumstances, or departure approved by the shareholders’ meeting): the vested equity may be retained, and the unvested equity is repurchased by the company (price negotiable);
• Bad-faith departure (e.g., violation of a non-compete covenant, starting a rival business, or major negligence causing company losses): even the vested equity may be subject to mandatory repurchase by the company (at a price below market).
  

Point 3: Source of repurchase funds

A company’s repurchase of equity requires funds; it is advisable to provide in the shareholders’ agreement that:

• The company establishes an equity repurchase reserve;
• Or the other founders share the repurchase funds in proportion to their shareholdings;
• Or it is agreed that the repurchase price be paid in installments to ease financial pressure.
  

Point 4: Set a “equity put option”

If a founder departs in good faith, it may be agreed that they have the right to put the vested equity back to the company (the company bears the purchase obligation), at a price calculated by fair value. This both secures the founder’s exit channel and avoids the equity remaining in limbo.

Point 5: Periodically review and update the Vesting clause

As the company develops, the Vesting clause may need adjustment (e.g., extending the vesting period or adding performance assessment metrics). It is recommended to review it once a year to ensure the mechanism matches the company’s stage.

VI. Risk Warnings: Common Loopholes in Vesting Clauses ⚠️ Risk Alert

Risk 1: Stipulated only in the shareholders’ agreement but not written into the articles

If the Vesting clause is reflected only in the shareholders’ agreement but not in the articles, its effect against third parties is weaker. For example, if a founder transfers unvested equity to a bona fide third party, the company may be unable to assert the repurchase right.

Recommendation: Incorporate the core clauses (such as the equity repurchase right and transfer restrictions) into the articles and file them with the registration authority at the time of industrial and commercial registration.

Risk 2: An overly long cliff causes founder attrition

Although a 1-year cliff is customary, if the company is at an early stage, founders may leave because they “cannot wait.” Some companies adopt a “no-cliff” design (vesting starts upon joining) or shorten it to a 6-month cliff.

Recommendation: Flexibly adjust the cliff duration according to the company’s actual situation and the founders’ contributions.

Risk 3: Overly loose accelerated vesting clauses hinder M&A

If a “single-trigger acceleration” is agreed (full vesting upon the company being acquired), the acquirer may abandon the deal due to excessive cost. Investors usually require it to be changed to “double-trigger acceleration.”

Recommendation: Communicate the Vesting clause with investors before financing to avoid later disputes.

Risk 4: Failure to stipulate equity treatment upon exit leads to deadlock

Some companies, only when a founder departs, discover that key clauses such as the repurchase price and payment method were not agreed, leading to a stalemate between the parties. The founder may use the “equity chip” to coerce the company, affecting normal operations.

Recommendation: Provide in detail in the shareholders’ agreement the rules for equity treatment upon departure, including the repurchase price formula (e.g., based on net assets, or a discount to the latest financing valuation).

Risk 5: Ignoring tax implications

Equity repurchase may involve individual income tax (e.g., where the repurchase price exceeds the acquisition cost). It is advisable to stipulate the allocation of tax liability in the agreement to avoid disputes.

VII. Recommendations: 3 Things Founders Must Do

Recommendation 1: Review the existing equity structure immediately

If you have already founded a company but have not set up a Vesting clause, it is not too late to remedy it now. You may negotiate with the existing founders and sign a supplementary agreement providing for “future equity vesting in installments” or “transfer restrictions on already-held equity.”

Note that for vested equity (i.e., equity already registered in one’s name), if the founder does not agree to a put or restriction, the company cannot force it. Therefore, the earlier Vesting is set up, the lower the cost.

Recommendation 2: Improve the Vesting mechanism before financing

During due diligence, investors usually focus on the stability and predictability of the founders’ equity. If a Vesting clause is found to be lacking, they may require rectification, or it may even affect the investment decision.

It is recommended to cooperate with a lawyer before the first round of financing to design a Vesting scheme that meets investor expectations (usually including a 4-year vesting period, a 1-year cliff, and double-trigger acceleration).

Recommendation 3: Regularly review equity arrangements with a lawyer

Equity arrangements are not “once and for all.” As the company grows (e.g., bringing in new founders, implementing equity incentives, or preparing for an IPO), the Vesting mechanism needs continuous adjustment. It is recommended to communicate with a lawyer at least once a year to ensure the equity structure always serves the company’s interests.

Special reminder: If you are facing a founder departure dispute or need to design a Vesting clause, it is advised to consult a professional lawyer immediately. The window for handling equity disputes is usually short, and delay may lead to a passive position.

VIII. Conclusion

The equity vesting clause (Vesting) is not a symbol of “distrust,” but a necessary mechanism to protect the long-term interests of all founders. It ensures that only those who truly advance and retreat with the company can ultimately obtain the equity reward.

For entrepreneurs, designing a Vesting mechanism is an “art of balance”: it must both prevent a founder from leaving midway and taking equity away, and avoid excessive restrictions that deter outstanding talent. Only by customizing a Vesting scheme within the legal framework, in light of the company’s actual situation, can one achieve “a clean break and a well-founded exit.”

If you have any questions about the design or implementation of a Vesting clause, please contact Lawyer Kevin Jun Lin’s team. We will provide you with a professional equity structure solution based on factors such as your company’s stage, financing needs, and founder composition.

Lawyer Kevin Jun Lin . Legal Treasure of the Company · Focused on corporate legal practice

Disclaimer

This article is for general reference only and does not constitute legal advice or opinion. For specific legal issues, please consult a professional lawyer. The cases herein are adapted from real events, and the company names and details involved have been anonymized.

Lawyer Kevin Jun Lin

Senior corporate lawyer · Industry legal practice expert

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About the Zhenpin Lawyer Team

Lawyer Kevin Jun Lin — Today’s Lead Author

A doctoral candidate in civil and commercial law at China University of Political Science and Law (in-service). Combining depth in company law theory with extensive practical experience, specializing in company law, equity disputes, corporate compliance system building, data compliance, and product quality disputes.

Lawyer Yan Ge: Founding partner of the law firm, decades of frontline legal experience, with hands-on practice across the courts, supervision, judiciary, and enterprise dimensions.

Lawyer Lin Bing: 27 years in practice, with dual backgrounds in law and finance, having handled over 2,000 litigation and non-litigation matters.

Further Reading

• When a Founder Suddenly Dies, Who Gets the Equity? Without This Clause in the Charter, Everything Changes
• Non-Compete Clauses: What Can You Do When a Partner Starts a Rival Business?
• Profit Distribution: How to Divide Profits? No Agreement Means Disaster
• Redemption Rights: What Must Founders Repay When Investors Withdraw?
• Valuation Adjustment Mechanisms (VAM): The Hidden Knife When Investors Hand You Money
• Drag-Along and Tag-Along Rights: What Can Minority Shareholders Do When Majority Shareholders Want to Sell?

If you need professional support in shareholder agreements, investment term review, or equity disputes, please contact Lawyer Kevin Jun Lin (Shenzhen corporate lawyer) for a one-on-one consultation.